10 Year Treasury Credit Default Swaps Spike (Chart / Video)

I knew there were treasury interest rate swaps, but treasury credit default swaps? You've heard in the news that credit default swaps, the ability to swap defaulted debt securities w/ a counterparty at par, have been spiking due to the large amount of banks going under. The swap spread priced in basis points (yield) is the cost of protecting the debt from default. The swap spread increases as the default risk of the underlying security increases. There are U.S Treasury Default Swaps quoted in euros. You can find real time data at CMA DataVision or the Bloomberg Professional service for a fee. With the thought of almost a $trillion in government bail out money passing congress, it looks like people are starting to bid up U.S Treasury Default Swaps due to the current state of the U.S balance sheet. Here is a chart sourced from the article "A default by the US government is no longer unthinkable" from telegraph.co.uk on 9/20/2008. The chart is no long available with that article, but I found it somewhere else. Also Treasury CDS spreads hit a new record 4 days later (9/24/2008 Reuters article below).


"US 10-year Treasury CDS widens to record 29.2 bps-CMA
Wed Sep 24, 2008 6:28am EDT

LONDON, Sept 24 (Reuters) - The cost of insuring 10-year U.S. government debt against default rose to a record high on Wednesday as investors fretted over the feasibility of the government's $700 billion plan to contain the financial crisis. Credit default swaps on 10-year Treasury debt expanded to 29.2 basis points -- its widest ever -- from 26.5 basis points on Tuesday, according to CMA, a specialised data provider. CMA said CDS on five-year widened to 22.0 basis points from 20.5 basis points. (Reporting by Emelia Sithole-Matarise)"

Credit ratings agencies, like Moody's and S&P, also have an effect on the pricing of risk, or swap spreads in this case. When they lower the rating on an entities debt, interest rates rise as investors demand higher payments for the extra risk. Recently Moody's and S&P have thought about lowering the AAA rating on U.S government debt possibly in the next 10 years if they keep piling on trillions of debt. That's what is happening here, swap spreads are widening because risk is being repriced appropriately.
"S&P says pressure building on U.S. "AAA" rating
Wed Sep 17, 2008 5:29pm EDT

NEW YORK (Reuters) - Pressure is building on the pristine "AAA" rating of the United States after a federal bailout of American International Group Inc, the chairman of Standard & Poor's sovereign ratings committee said on Wednesday. The $85 billion bailout of AIG on Tuesday by the U.S. Federal Reserve "has weakened the fiscal profile of the United States," S&P's John Chambers told Reuters in an interview. "Lack of a pro-active stance could have resulted in further financial stress and put pressure on the U.S. triple-A rating," Chambers said. "There's no God-given gift of a 'AAA' rating, and the U.S. has to earn it like everyone else." The cost of insuring 10-year U.S. Treasury debt against default rose on Wednesday to a record high, a day after the government rescued insurer AIG with an $85 billion loan. At one time, AIG was the world's largest insurer, ranked by market value. At midday on Wednesday, AIG's stock was down 33 percent at $2.50 on the New York Stock Exchange. Ten-year credit default swaps, or CDS, on Treasury debt widened 3 basis points to 26 basis points, according to data from CMA DataVision. This means it costs $26,000 per year to insure $10 million of U.S. Treasury debt against default. Five-year credit default swaps on Treasury debt were steady at 21.5 basis points. That compares to 9.8 basis points on German 5-year CDS and 13.2 basis points on German 10-year CDS, CMA said. Earlier this month, S&P affirmed the "AAA" sovereign rating of the United States, noting risks to the U.S. credit profile, including the deteriorating credit profiles for most U.S. financial institutions over the past 12 months, S&P said in a September 3 statement........click for more article."

IOUSA, U.S Is Going Broke, Fiscal Deficit Ratios, Trends (Charts)





I just saw the movie I.O.U.S.A, where the film follows former U.S. Comptroller General David Walker as he travels the country explaining America's unsustainable fiscal policies. With the US Government now proposing a trillion dollar bail out it shows how serious this problem is. I have to say I'd rather be writing about stocks but I think this issue needs to be addressed for the future health of our market, especially if there is a serious crisis. This will probably be the most depressing post and hopefully a sign of a market bottom. Here is the movie trailer and an interview with David Walker on Lou Dobbs.

Will The Leveraged Consumer Remain Resilient? Analysis of Real Earnings, Spending, Employment & Leverage

With all of this bail out news on Wall Street, I'm wondering how all of it affects the consumer. Will the consumer remain strong during this financial crisis? All of this mortgage bailout talk did not include consumer debt until now. I just read in Bloomberg tonight that "U.S. Treasury Widens Scope of Plan to Buy Bad Debt" (Bloomberg)

"The change suggests the inclusion of instruments such as car and student loans, credit-card debt and any other troubled asset. That may force an eventual increase in the size of the package as Democrats and Republicans in Congress negotiate the final legislation with the Bush administration, analysts said."
As with mortgages, loose lending standards were also applied to credit card debt, lines of credit, auto loans and education loans. It's interesting that the Fed's consumer debt/disposable income ratio hasn't really run out of control, but there is a trend of rising delinquencies and charge-offs at banks holding these consumer credits. With less jobs being created and unemployment rising this could definitely create more write downs in the banking sector, which is probably why the Government included them in the bailout. Plus consumer debt is securitized just like mortgages, and look what happened to Citigroup last quarter (Citi loses $176m on credit-card securitizations). "Citigroup Chief Financial Officer Gary Crittenden said North American credit card losses could exceed historical peaks, and consumer credit costs might have a "meaningful" impact on results for the rest of the year". Also as you can see from the charts below, real personal income has been falling due to inflation mainly because high gas prices and food costs have squeezed the consumer. So again, from here it all depends on how resilient the consumer is and how fast these banks get repaired when determining the fate of the economy going forward.

Personal Income & Spending (Source: Briefing.com)


Real Avg. Weekly Earnings (Source: BLS.gov)


CPI YoY% (Source: Briefing.com)


Non-Farm Payrolls (Source: Briefing.com)


Treasury Listened To Bill Gross, New $700 Billion Balance Sheet, Bailout Analysis

It looks like the Government is listening to Bill Gross, the manager of the biggest bond fund in the nation ($50 Billion Pimco Total Return Fund PTTAX). He stated earlier in his September investment outlook that there needs to be a new balance sheet to put an underlying bid in the market, where some assets and debt securities are undergoing forced liquidations. There also might be a chance that Bill Gross gets to manage the new balance sheet.

"to ultimately stop this asset/debt deflation, a fresh and substantial new source of buying power is required. This became all too obvious as the Treasury’s attempt to entice additional capital into Freddie and Fannie came up empty. Yet this same dilemma is and will continue to confront all highly levered institutions in the throes of asset liquidation. Without a new balance sheet, their only resort is to sell assets, which in many cases leads to further price declines, or ultimately debt liquidation/default." -Bill Gross

Interesting UltraShort Dow 30 ETF (DXD) SEP 67 Put Option Activity.. What Happened here?

I wrote about the DXD put option open interest configuration last night when I saw there was a HUGE chunk of puts open at the 67 out of the money strike. Also overnight Dow futures were up 119 so I thought this could actually work out if it was speculative in nature. However this morning the open interest did not make sense given yesterday's volume. It looked like it could've been a buy to open error in the SEP 67 PUT Open Interest because it showed 9,527 OI on Tuesday (9/16), 77 contracts traded on Wednesday, and 760 OI on Wednesday (9/17). Open interest updates on the next day. The volume of 77 on Wednesday would not have closed out 8,767 contracts. Plus they were out of the money at the time so they would not have been exercised. There must of been blocks that should've been closed rather than opened to create such a large open interest number..I wish I saw the volume on 9/15.

Last night I posted this picture of the SEP put option chain for Tuesday (9/16) and also had the visual open interest configuration which showed the huge put block at the SEP 67 strike (at the bottom). This of course stood out as it was a huge signal for a bearish DXD trade since someone was willing to pay $952,700 to have the option to sell 952,700 shares at $67, or $63.8 Million, if it was in the money. The crazy part of it is the option was actually IN THE MONEY TODAY! The DXD closed today at $65.50 down 7.25%! So did anyone end up getting paid here?

Morgan Stanley Implied Volatility spikes to 277%, CDS Spreads Widen, Potential Merger w/Wachovia

Wow all of the banks are scrambling to merge to save themselves from this disaster!. This is even happening in the UK (Lloyds to buy HBOS in $50 billion deal). During the past few days I saw that HBOS Plc. lost about half its value at a point.

Traders bid up volatility on Morgan Stanley's options on Wednesday; sourced by the ISE Exchange, implied volatility in Morgan Stanley spiked up to 277.23%!! Today's stock price hit a low of $16.04 before getting bid up to $21.75 (-24%) at the close, which was probably due to the breaking news after the bell that there were talks between Wachovia and Morgan Stanley. It looks like the stock was initially bid up during after hours, but it's now off 75 cents to $21. The option market was very active, especially in the September 15 Puts where 55,855 contracts exchanged hands, the most out of all strikes. Call volume was also active with in- and out- of-the-money contracts losing more than 60% of their value with 47,795 contracts traded at the SEP 25 Calls, and 48,393 at the Sep 30 Calls. Calls actually outnumbered puts in the SEP month but puts more than doubled calls in October, so there are either trading strategies taking place or conflicting positions. The total put/call volume ratio still had a bearish bias at 1.43. With the most active contract, Sep 15 Puts, trading way over open interest and requiring the price to go below $13.65 to make a profit also added to the bearish bias. News about their widened CDS spreads also allowed the shorts to bring down the stock.
The cost to insure a $10 million block of Morgan Stanley debt for one year reached $2 million to $2.2 million upfront, plus the annual contract cost of $500,000, at one point Wednesday afternoon. Last week, Morgan Stanley swaps cost about $325,000 annually, with no upfront cost. Source

There were also articles regarding hedge fund clients leaving their prime brokerage..
Sept. 18 (Bloomberg) -- Morgan Stanley is losing hedge-fund clients who are concerned that a record drop in the New York- based investment bank's stock threatens its finances, investors and industry executives said. Hedge funds that account for less than 10 percent of Morgan Stanley's prime-brokerage balances this week withdrew their money or told the firm they planned to, according to a person with direct knowledge of the matter. Source

So will volatility eventually be sold and shorts squeezed due to the merger talk and the fact that Morgan Stanley has less exposure to the sub-prime disaster? Or are there bigger problems brewing within their prime-brokerage unit. We shall see what happens...

Chart Source: ISE.com

Are We Seeing Capitulation in the Dow, S&P Indices? Where's the next possible bail out?

It's not great to hear the words "nationalization of AIG". Both the Dow Jones Industrials and S&P are now below the July '08 lows, at 10,690 (DJIX), and 1,172 (SPX). From the looks of the charts below, the Dow needs to hold the 10,683 support level made in summer 2006, and the S&P needs to hold the 1,150 major support level made in 2004. These 350-500 point moves to the downside are definitely putting some huge holes in the charts, and are continuing to wash out forced sellers and weak holders on both the retail and institutional side. Is the market experiencing capitulation which usually creates a bottom? It all depends if banks keep going under. Be on the look out for a huge 300-400 point move to the upside on some good news, if and when that happens. Once a strong rally occurs it will create a major support level that attracts buyers if retested, possibly creating a double bottom.

chart source: stockcharts.com

chart source: bigcharts.com


I'm wondering when the tax payers will start bailing out themselves, or consumer debt (credit cards, auto loans, school loans, plasma tv loan). If the economy slows dramatically and unemployment continues to rise, a consumer debt crisis could emerge which would hit consumer debt securities, as well as commercial banks holding the debt bringing more write downs. I'm going to find some data on current consumer debt levels and compare with consumer spending, income and unemployment charts.

Credit Default Swap Index, ABX, CMBX Technical Analysis

The Lehman news is widening CDS spreads in the Credit Default Swap Market. I looked at the Liquid 50 Investment Grade Credit Default Swap Index Future chart at cbot.com which is priced in spread. The underlying CDS are driving the problems of this financial disaster because all of these big banks originated swaps to protect from defaults on debt securities. When a big bank like Lehman or Bear become insolvent and have CDS (counterparty) obligations on their balance sheet, they might not be able to pay par value when there's a default. What if Lehman re-insured a credit default swap with Bear Stearns? Well, the tax payers have it now.

It's crazy because these banks were investing in sub-prime real estate securities and at the same time protecting other firms making the same investments.  Also book value means nothing whatsoever on Lehman's balance sheet due to their illiquid toxic debt investments. As Lehman stands today at $0.22 on the market, they're most recent quarter book value per share is $34.88.  Nothing was marked-to-market until the actual bankruptcy aka a big fat 0.  Here is the chart of the Credit Default Swap Index from the CBOT.  It's an investment grade index, not high yield. As you can see in the chart, we're still not at the March 2008 high of 420bps when Bear Stearns was sold but it did break above the June 2008 highs. The index should be watched closely because if things get worse it could retest the Bear Stearns high.  However if spreads start to narrow and spreads fail to make new highs, the credit crisis could be at it's peak. Let's just hope enough people don't listen to Professor Roubini at NYU and create a run on the retail banks. Then it would truly be a great depression and not just a structured finance depression. I think after all of this we need to bring back the gold standard. We'll see how the other big I-banks and Insurance companies come out of this...




Here's a chart of the of ABX 2006-2 AAA asset backed securities index via CDS from markit.com, which quickly turned sour as you can see. It's priced like a bond.  When these indexes were first originated they were priced at par or 100.  Since the securities in the index were downgraded after 2006 origination, prices plummeted and cost of protection spiked.  Hedge fund manager John Paulson made billions of dollars in 2007 shorting this index. The index bounced off of the 68 resistance to the downside and could be headed toward the 61 support level.



The next chart from markit.com is the 2006 CMBX AAA tranche, or AAA rated commercial mortgage backed securities index originated in 2006 priced in spread via CDS. You can see that spreads widened recently and broke out of a downtrend. It could retest old highs.



Chart sources: markit.com, cbot.com

Lehman Disaster Sending Index Futures Lower, BAC Buys MER

Well the overnight futures opened and at 8:00, according to insidefutures.com, The S&P Overnight Futures are -36.6 and the Dow Jones Industrials Overnight Futures are -286. Here are the 90 minute charts going back 3 weeks for the overnight futures. You can see the big gap down tonight. It's crazy how all of the big investment banks are all intertwined with counterparty Credit Default Swap risk exposure, and with Lehman insolvent it could bring big problems. There are some good articles about the counterparty CDS risk on bloomberg.com.

S&P Overnight Futures (insidefutures)


Dow Overnight Futures (insidefutures)


While I'm writing this news update just popped up. Bank of America Agrees to Buy Merrill Lynch for $44 Billion: WSJ- AP. That's a 38% premium to its $21 book value for its most recent quarter! Is BAC going to make MER write downs in the future??? It has to be related to the billions of counterparty swap exposure because it doesn't seem like the right time to make a 38% premium bid over book value for a financial institution.

It will be interesting to see if the Bank of America/Merrill news out weighs the Lehman Brothers News. Of course if there's deal for Lehman to sell the Neuberger Berman unit by Monday morning and survives, things might not be that bad!

And just think, it all started with the two Bear Stearns Subprime funds that blew up in July, 2007. Here's the letter Bear sent to shareholders, from the WSJ.

Long Term Dow & S&P Technicals, Near Term SPY, DIA Options

I can't stop posting about the indices because the market is at an inflection point of either a surprise rally or a HUGE move to the downside. I'm going to look at the long term trend and near term sentiment indicators, including the 25 year chart of the Dow and S&P 500 from barchart.com with technical analysis. Both charts show the 25 year long term trend line hitting today at lower levels. More significant in the S&P than the Dow. Click the pictures to zoom in.

Now looking at near term sentiment with options of the DIA and SPY (exchange traded funds) I see that implied volatility spiked recently due to the pending announcement of Lehman's fate, as well as problems with AIG, WaMu and issues with our economy . It looks like the SPY has more bearish sentiment than the Dow because it's Put/Call Open Interest ratio is much higher and it has very high open interest concentrations in some out of the money puts. The DIA has a Put/Call OI ratio of 1.03 and the SPY has a ratio of 1.57. Comparing the option volume, the DIA has more calls being traded than puts having a Put/Call Volume ratio of .78 (near year lows), and the SPY has a ratio of 1.40 which is a huge difference. If you look at the DIA Open Interest Configuration at schaeffers research there are actually some huge concentrated call positions at the Sep and Oct expiration's which is surprising. I'm thinking that the S&P 500 has more exposure to the banking sector giving it more negative sentiment.


Dow Jones Index 25 Years (barchart.com)


S&P 500 Index 25 Years (barchart.com)


SPY Open Interest (schaeffersresearch)


Also this just hit the Wall Street Journal at 2:00p Sunday (9/14/2008)..

"Barclays claims to be walking away from a Lehman deal but could return, sources familiar with the situation say. The current deal structure would require a Barclays shareholder vote. Government reluctance to provide funding remains a deal hurdle. More details to come." Full Article

This could get ugly.

Dow Chart and Article Comparison From 2000 vs. 2005

This is a historical analysis of the Dow Jones Industrial Index during years 2000 and 2005. These were taken from a pdf I made that compared news stories from both years when the Dow Jones Industrials Index hit the 11,000 range. It's interesting to compare this to now where the Dow is close to the 11,000 level and that the index hasn't really increased in value for 10 years! Click on image to zoom in.

US Treasury Notes & Bonds (2s, 10s, 30s), 10 Yr TIPS Spread Update (9/11/2008)

Due to the market chaos there seems to be a flight to quality in the treasuries. Now traders are even talking about a possible rate cut with commodities coming down, dropping the commodity inflation scare from the FEDs mind. I think there needs be a big flush to the downside to wash out all of the negative sentiment in order to restore the equity market. I wish there was some sort of debt liquidation price chart due to all of the reorganizations and huge bank debt blocks exchanging hands at distressed levels. I feel once this chart bottoms out the markets will be ready to move higher. I could only imagine the low ball bids being offered for Lehman's Neuberger Berman unit and it's commercial real estate portfolio due to the health of the market. It's pretty scary that these huge banking institutions are selling distressed assets to survive when they should be the ones providing capital to the private market and citizens. The billionaire funds better step into this market or there will be continued write downs as lending stays tight and our economy drags down the global economy.

I'm also wondering if the Bear Stearns, Fannie, Freddie and Lehman stories are the last to be told. The general economy could be the next story, but once the Lehman news of an asset sale, takeover, or government bailout comes out that could be the final flush or bottom. However if the economy's downside strength outweighs these large corporate restructuring catalysts it could take longer than expected.

I've enclosed charts along with technical analysis of the U.S. Treasuries (source: barchart.com), Yield Curve (source: stockcharts.com) as well as the 10 Yr TIP spread (source: clevelandfed.org)

2 Yr Note Historical Chart


10 Yr Note Historical Chart>


30 Yr Bond Historical Chart




10 Yr TIPS Spread

U.S Economic Update (Economic Data, US Indices, VIX Trend)

It looks like the Government is finally going to subsidize the GSE's (Fannie Mae and Freddie Mac) and possibly lend $50B to GM. Local banking institutions keep going under and oil prices have been falling due to falling imports/demand, however the housing market could be stabilizing as housing inventories get worked off on a month to month basis. Still the August housing starts and permit data still shows weakness. The dollar has also improved. I believe currency traders are sensing a global slowdown, putting hard assets out of favor and putting a long bias into the USD. Also recently Fed officials believed the next rate move would be up. Things aren't looking that great for the consumer either with real personal spending and income not outpacing inflation and unemployment data reaching levels not seen for 5 years. Unexpectedly Q2 GDP was revised higher to 3.3% from the initial 1.9% reading, due to strong foreign exports utilizing the cheap US Dollar. The durable goods report in July increased 1.3%, which was higher than the 0.1% increase expected, due to foreign demand for commercial air crafts. However this could be a temporary phenomenon because a global slow down and a higher US dollar would lower exports. In the US increased unemployment and inflation data could affect real consumer spending further which would weaken retail sales data. Eventually the higher US Dollar and lower oil prices would lower inflation and lower the squeeze on the consumer's pockets.

The indices could revisit their old lows, or double bottom, if asset and debt liquidations continue and private institutions/overseas buyers fail to put an underlying bid on our country's distressed assets. I'm not sure how the market will respond if the GOV/U.S tax payers end up bailing everyone out (GM, Banks and GSE's). If the U.S tax payers buy all these distressed assets and hold on to them for years, the assets would eventually increase in value and the tax payers could receive a nice dividend check in the mail when the assets are sold back to the private enterprise at a profit! RIGHT?? So US tax payers are now a pooled distressed US investment fund putting a bid under the distressed assets, possibly saving the market and their home values. It's an automatic bottom with a short term cost. If the U.S Government Federal Reserve would stop printing money and spending like crazy it could actually benefit us down the road. If that could only work.

News Flash:
Officials announce takeover of mortgage giants
Auto industry to press Congress for $50B in loans
U.S. unemployment rate hits 6.1%, highest level in five years
Oil hits 5-month low as demand shrinks
New-Home Sales in U.S. Increase From 17-Year Low
Durable goods post strong gains in June, July
Leading economic indicators fell sharply in July


Friday's Energy Price Action Predicted Hurricane Gustav's Severity

It's interesting that the capital markets on Friday predicted the severity of Hurricane Gustav better than most of the weather stations who were predicting the next Katrina. Oil and natural gas prices, along with energy stock price actions, were predicting that Gustav wouldn't effect the energy infrastructure 3 days before it even hit. The anticipation of Gustav's force matching Katrina's did put a bid into energy prices and oil/gas stocks at the beginning of the week but it faded on Friday when the prices of oil and natural gas ended in negative territory. The market was right. Even though production was halted, Gustav caused limited damage to the Gulf's energy infrastructure and oil futures dropped over $7 as a result. The falling energy prices were also helped by a stronger dollar, lower demand and no direct international conflicts. Never Fight The Tape!!


5 Day Oil Price


5 Day Natural Gas Price


5 Day Chesapeake Energy Price


Chart Source: Yahoo Finance